Mozambique’s Guarantees on the Tuna Bonds: Can They be Repudiated?

Mark Weidemaier & Mitu Gulati

There have recently been headline articles in the press about three loans made to state-owned security companies in Mozambique (see here, here and here) and guaranteed by the government. The reason for the attention to these loans – made originally between 2013 and 2014 by Credit Suisse and the Russian bank VTB – is that US federal prosecutors are pursuing charges against a number of bankers from Credit Suisse and government officials from the Mozambique finance ministry. (Somehow the VTB folks seem to have escaped so far.) To simplify, these individuals were allegedly involved in siphoning off funds ostensibly intended to support Mozambique’s fishing industry and enhanced security in its territorial waters. Concretely, the loan was supposed to be used for new boats: some to catch fish (hence the moniker “tuna bonds”) and others to bolster the coast guard (“maritime surveillance”).

Instead, much of the money seems to have disappeared. The loans went into default; few tuna were caught. For contemporaneous reporting, see here, here, and here.

We have been thinking about debt repudiation of late. And Tracy Alloway of Bloomberg (and formerly of FT Alphaville) specifically got us thinking about the Mozambique tuna bonds on a recent podcast for Bloomberg’s Odd Lots (Tracy is a spectacular host).  Prompted in part by Tracy, we wondered--now that the corruption on the part of the agents for the banks and agents within the Mozambique finance ministry has been revealed—whether the government can repudiate the loans on the grounds that they were infused with illegality.

One of the three loans is worth treating separately from the others. This loan was made specifically for tuna boats. It involved an $850m bond for a company called Ematum—allegedly a sham—which has since been converted from a state-guaranteed bond to a sovereign Eurobond. For the other two loans, the repudiation question—since the borrower companies seem to have no assets—is whether the state can withdraw its guarantee on account of the corruption. There is a good argument that the answer is “yes.” Contract law in many key legal jurisdictions makes contracts infected by corruption and bribery voidable.

Some years ago, one of us analyzed this question in an article with Lee Buchheit, where we analyzed the question of “corrupt debts” (here – at pp 1234-39). We quoted this illustrative language from a 1960 New York Court of Appeals case: “Consistent with public morality and settled public policy, we hold that a party will be denied recovery even on a contract valid on its face, if it appears that he has resorted to gravely immoral and illegal conduct in accomplishing its performance.” Jeff King, in his new book on Odious Debts (here – at pp 119-23), has a section on sovereign obligations infected by corruption and makes much the same point under English and a number of other laws. And Jason Yackee tackles the corruption defense for sovereigns in the BIT context here. Bottom line: There is a pretty good defense here.

One objection to this argument—which we mentioned in our previous post on Puerto Rico’s attempt to avoid $6 billion in debt (here)—is that courts sometimes impute the wrongdoing of past government officials to the current government. For instance, in Republic of Iraq v. ABB et al., 768 F.3d 145 (2d Cir. 2014), the post-Saddam government of Iraq tried to disclaim responsibility for the previous government’s involvement in corrupt transactions. The Second Circuit, however, refused to draw a distinction: “where a plaintiff in Iraq’s position bears fault, it does not escape the consequence of its wrongdoing on the basis of a change in leadership.”

We are not inclined to read too much into this reasoning, which may be limited by its context—Iraq was trying to recover damages under RICO, not avoid a contractual obligations—and by its specific facts—including the fact that the corruption was “coordinated pursuant to the policies of an entire government.”

Finally, it’s worth considering the $850m Ematum bond, which in 2016 was “sanitized” into a sovereign bond of Mozambique (its first ever eurobond, sadly). That bond was apparently restructured into another eurobond plus a so-called “value recovery” instrument giving investors some of Mozambique’s future gas revenues (here). Government officials in Mozambique proclaimed this restructuring to be a good deal. But was it really? If this were still a guaranteed instrument, the government would have a credible argument in favor of withdrawing the guarantee. If successful, withdrawal would have left investors with essentially valueless claims. But by converting the guaranteed debt of a shell company into a direct sovereign obligations, the government likely sanitized the debt from challenge.

We wonder why the Mozambique government did this sanitization exercise. Did officials think it would help improve the government’s perceived creditworthiness? Or did they hope to deflect attention from the initial corruption surrounding the loan? (If the latter, it didn’t work.) As we understand matters, investors in the two other dodgy loans wanted a similar deal (indeed, there were discussions on the subject at the end of 2018). Apparently, the holders of the “sanitized” government bond objected on the basis that the guarantees enjoyed by holders of the other two bonds were illegal (see here). Hmm.  (Also, the IMF was already irate about the Mozambique government have failed to adequately disclose to it their debt shenanigans).